Stock Market Summary

It has been a long, rather slow economic expansion cycle. S&P profits started strong, but hit a snag
in late 2014, and net per share is only now likely to trend up to new highs. The big story has been
the dramatic increase in the SPX p/e ratio since the end of 2011. Investors have been confident
enough in the Federal Reserve to backstop real economic growth, however anemic on an historic
basis, to direct their attention to the policy of super low interest rates supported by nominal inflation
to lower the discount rate on future cash flows from stocks and thereby hike the p/e ratio. It has
been a repeat of the 1960s despite the tepid economic and productivity growth.


The end of quantitative easing by the Fed as 2014 wound up launched a negative adjustment
process for the economy and stocks, but as private sector liquidity remained moderately positive
enough to fund ongoing cyclical expansion, the economy and the stock market regained a new lease
on life early last year with enough promise to support a rise in stocks to new highs. SPX Monthly


it is not clear that the economy and profits would support much of any gain in stocks this year,
but investors have been energized by the promises of the new Trump administration to foster
stronger economic growth in the years straight ahead and have revised outlooks to reflect faster
profits growth and the expectation that inflation will be tame enough not to drive the Fed to jack up
interest rates too quickly. For investors, it is not the best of all worlds, but it is good enough.


There is capital slack in output capacity and ample liquidity in the banking system to support
a good two years of faster economic growth, but the labor market has already tightened and it
remains to be seen whether new demands on labor can be satisfied given elevated skill set
requirements, a lack of worker mobility and eventual stronger wage demands.


So far, we do not have blueprints of new fiscal stimulus programs, possible negative Trump
forays into restricting trade and the willingness of the Fed to cut the new crew enough slack
to pull it off. Big questions, yes, but investor confidence has remained unphased.


We also have a stock market that is running about 5% above fair value and one that has to be
sensitive to the tradeoff between growth and inflation given the high dependence of investors
on seeing interest rates that remain modest by historical standards.